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Student Loan Debt in Bankruptcy FAQ

Mory Brenner, Esq.

Q. Does the Bankruptcy court view student loan debt in a different way than either credit card debt or mortgage debt?

A. Yes. Bankruptcy courts treat student loan debt in a special way. Credit card debt, mortgage debt, medical debt or almost any other debt does not rate the special treatment that bankruptcy courts afford to student loan debt.

Q. Why does student loan debt warrant that kind of attention from the bankruptcy court?

A. Debtor protection from the Bankruptcy court and the power of the Bankruptcy court to relieve the debtor from obligations he or she legitimately incurred through a chapter 13 bankruptcy derives from powers granted to the Bankruptcy court by the United States federal government. It just so happens that the United States federal government also guarantees student loans. With student loan debt rising above $1 trillion, they have good reason for concern.

Q. So you cannot make the Federal Government forgive a debt that you owe the Federal Government by using a debt relief program like the United States Bankruptcy court against themselves?

A. Yes.

Q.What about debt from a private school or a student loan debt from a private scholarship fund?

A.Sometimes student loan debt with no link at all to Federal student loan programs may be treated by the bankruptcy court in a manner much more like credit card debt or medical debt than student loan debt. Loans from non-profit organizations must get the same treatment as those guaranteed by the Federal Government.

Q.What would be an example of a student loan that would not be discharged in a bankruptcy court?

A.Through your school you arrange a loan that goes through a large national bank, with the obligation to the bank guaranteed by the Federal Student loan agency known as Sallie Mae.

Q.What would be an example of a student loan that would be discharged in a bankruptcy court?

A.The United Organization of Semi-Professional Tidily Winkers, a for-profit association, makes you a loan to study Tidily Winking at the University level.

Q.I see, strength and size of the organization granting the student loans dictates how it is treated.

A.No, not at all. The key element revolves around the true source of the money and the guarantee, if any. If the Tidily Winkers had gotten their money from a Federal Grant and had given you a student loan guaranteed by some agency in the Federal Government, it might not be dischargeable in bankruptcy. On the other hand, a student loan made from funds provided through a private endowment through a major University not guaranteed by anyone would likely get discharged by a bankruptcy court.

Q.I heard that if you have an unusual hardship you can still have these special kinds of student loans discharged, isn’t that true.

A.Yes, there does exist a special exception for “undue hardship” cases.

Q.My story is pretty sad so I should not have to worry about any of this, right?

A.No, not at all. The cases that fall under this exception are likely well beyond anything you have experienced or could even imagine.

Q.Give me an example of when a student loan debt that might not be eligible for discharge in a normal bankruptcy case would be dischargeable under the bankruptcy court’s undue hardship category.

A.Imagine that you got into a car accident and needed both legs amputated.

Q.Wow, that’s pretty extreme! Something that bad would have to happen?

A.No, I was just getting started. A double amputation would not be bad enough if you could still work without your legs in a field of study that you had used the loan to pursue. A chemical engineer, for example, could still work from a wheel chair.

Q.What if they had a million dollars in uninsured medical bills from the accident?

A.It does not matter. The court may want linkage between the undue hardship and the purpose of the loan, not linkage between the undue hardship and the reason you need bankruptcy protection.

Q.So when would the person in this example get their student loan debt discharged?

A.Imagine now if the person with the student loan debt had incurred all of the student loan debt to study ballet at the local university and furthermore had been employed as a professional ballet dancer for several years.

Q.So a ballet dancer who used the money to study ballet and could no longer pursue both the career for which they had studied been employed in because of a terrible hardship could get the special exception on their student loans?

A.Maybe, they could still teach ballet, which would be working in their field. Now if that person also had their arms cut off so they could not write about ballet and lost their voice box so they could not talk about ballet, that might be a case where the bankruptcy court would allow forgiving the student loan under the undue hardship exception. Note I said cut off and not broken, horrible injuries no matter how bad might not qualify if at some point in the future they might heal and allow the person work once more.

Q.That sounds insane. With a standard like that, in reality the hardship exception does not really exist.

A.Yes, the standards for the bankruptcy courts undue hardship forgiveness for student loans has a bar set so high it might as well not even exist for the vast majority of people with both student loans and special hardships.

Q.Are there any other ways for the bankruptcy court to wipe out or reduce student loan debts.

A.You could argue that they should reduce or eliminate a student loan debt where the school closed before you could complete the studies you had taken the loans to pay for and in cases where the loan was induced by some sort of fraud or criminal act by the school or the entity that set up the student loan. You might also try the undue hardship exception if the undue hardship affects one of your dependents as opposed to the debtor who took the student loans. Imagine perhaps that a dependent child had an accident that would require so much money for uninsured medical care, forever, that paying student loans created an undue hardship. Once again, these are unusual cases and very hard to get a bankruptcy court to approve.

Q.Does it make any difference if I am looking at if I should file chapter 13 bankruptcy or chapter 7?

A.When it come to chapter 13 vs chapter 7 bankruptcy if a student loan classifies as non-dischargable it would hold true for either chapter 7 or chapter 13 process. Student loan debt that the court finds discargable get treated as unsecured debt, like credit card debt.

Q.Then how should I approach the issue?

A.You may want to find a bankruptcy lawyer and briefly investigate or research the situation, but understand that winning a discharge of your student loan debt under the undue hardship exception or disputing the balance due remains a very unlikely possibility.

Q.So what should I do with my student loan debt?

A.If you are filing for bankruptcy anyway, you may as well discharge any of the student loans eligible for bankruptcy relief. For the rest, you can consolidate those student loans to ease the payments or try to settle the loans outside of the bankruptcy court. In some cases there may be so many student loans of the variety that may qualify for discharge that it makes sense to file a bankruptcy just to extinguish those debts.